Question

Explain the process of calculating the risk free rate for a certain country given the Local Currency Sovereign Ratings and how to get the default spread from this rating.

Answer 1

Risk free rate as the name suggest is the assured rate you get which you generally benchmark against a risky investment.the current treasury bill or T-bill, rate or long-term government bond yield are used as the risk free rate.

T-bills are considered nearly free of default risk because they are fully backed by the U.S govei.

Formulae

r=rf+b(rm-rf)

Where r= rate

rf=risk free rate

b=beta

rm=market return.

DEFAULT SPREAD.

The term default spread can be defined as the difference between yields of two bonds with different credit rating.